Evaluating companies using the discounted cash flow method

Draw up a detailed budget for forthcoming years. As investments in current and fixed assets have a significant impact on cash flows, a planning horizon should be chosen that includes the entire investment cycle.

As future free cash flow (FCF) of the available funds can only be realistically estimated for a certain number of planning years, a so-called residual value (future capitalized income) should be calculated beyond the planning period instead of the FCF. This residual value, generally 50% of the company’s estimated value, is calculated by capitalizing a representative FCF.

Each result is then discounted to the reference date set on the valuation date using the weighted average cost of capital. Discounting in this way brings all future returns back to the reference date at the time of the evaluation so that the present value of these returns can be identified.

The discounted present values are then deducted from the debt capital, and assets that are not essential to the proper operation of the company are added back. This produces the real value of the shareholders' equity (or the share price).